CONTRACTS FINALS ACJUCO 1
PART 2: CONTRACTS
ART. 1306. The contracting parties may
establish such stipulations, clauses, terms and
conditions as they may deem convenient,
provided they are not contrary to law, morals,
good customs, public order, or public policy.
(1255a)
FREEDOM TO CONTRACT GUARANTEED
The freedom to contract is both a constitutional
and statutory right.
WHAT MAY NOT BE STIPULATED?
Limitations on contractual stipulations.
a) CONTRARY TO LAW
 Contract entered into must be in
accordance with, and not repugnant to,
an applicable statute.
 Its terms are embodied in every contract.
Without need for the parties expressly
making reference to it, an existing law
enters and forms part of a valid contract;
it thus sets limits counter-balancing the
principle of autonomy of contracting
parties in Article 1306.
 The parties to a contract are charged with
knowledge of the existing law at the time
they enter into the contract and at the
time it is to become operative, and a
person is presumed to be more
knowledgeable about the law of his
country than an alien.
 Where a contract is entered into by the
parties on the basis of the law then
obtaining, the repeal or amendment of
said law will not affect the terms of the
contract, nor impair the rights of the
parties hereunder. This rule applies even
if one of the contracting parties is the
government.
 POLICE POWER - In short, all
contractual obligations are subject-as an
implied reservation therein — to the
possible exercise of the police power
of the state. Otherwise, important and
valuable reforms may be precluded by
the simple device of entering into
contracts for the purpose of doing that
which otherwise may be prohibited.
NOTE:
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A contract cannot be given effect if it is
contrary to law because law is superior to a
contract. (Art. 1409[1].)
The laws referred to are:
(1) those which are mandatory or prohibitive
in character;
(2) those which, without being mandatory or
prohibitive, nevertheless, are expressive
of fundamental principles of justice, and,
therefore, cannot be overlooked by the
contracting parties; and
(3) Those which impose essential requisites
without which the contract cannot exist
ACTS EXECUTED AGAINST ART.
1306
(1) Provisions of mandatory or prohibitory
laws are void, except when the law itself
authorizes their validity. (Art. 5.)
(2) Although a contract is the law between
the parties (Art. 1159.), the contracting
parties must respect the law which is
deemed to be an integral part of every
contract. (Art. 1315.)

(3) The provisions of positive law which
regulate contracts are deemed
incorporated or written therein and shall
limit and govern the relations between
the parties. Thus:
a. A contract intended to circumvent
and violate the law is void ab initio.
EXAMPLE:
 Thus, an agreement to convey a
homestead only after the lapse of the 5-
year period during which under the Public
Land Act, the owner was prohibited from
transferring his rights, cannot be
enforced for it is clearly illegal.
 The lessor cannot be validly a beneficiary
of a fire insurance policy taken by a
lessee over his merchandise and the
provision in the lease contract providing
for such automatic assignment of the
policy obtained without the prior consent
of the lessor is void for being contrary to
law and/or public policy under Sections
17, 18, and 25 of the Insurance Code.
(Pres. Decree No. 1460, as amended.)
The insurer cannot be compelled to pay
the proceeds of a fi re insurance to a
person who has no insurable interest in
the property insured.
b. A waiver by a party of his right to
bring an action for future fraud or gross
negligence is void as being against the
law (Arts. 1171, 1172.) and also public
policy. (Art. 1409[1].)
c. PACTUM LEONINA - A stipulation
which excludes one or more partners
from any share in the profits or losses
is void. (Art. 1799.)
d. Every stipulation exempting the agent
from the obligation to render an
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account to the principal shall be void.
(Art.1891.)
e. PACTUM COMMISORIUM - The
creditor cannot appropriate the things
given by way of pledge or mortgage, or
dispose of them. Any stipulation to the
contrary is null and void. (Art. 2088.)
Elements are as follows:
(1) There should be a property
mortgaged by way of security for the
payment of the principal obligation,
and
(2) There should be a stipulation for
automatic appropriation by the creditor
of the thing mortgaged in case of non-
payment of the principal obligation
within the stipulated period.’’
f. PACTUM DE NON ALIENADO - A
stipulation forbidding the owner from
alienating the immovable mortgaged
shall be void. (Art. 2130.)
NOTE:
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b) CONTRARY TO MORALS
Morals deal with norms of good and right
conduct evolved in a community. These norms
may differ at different times and places and with
each group of people.
Morals or good customs referred to in Article
1306 must refer to those not expressed in legal
provisions. The morals referred to are those

principles which are incontrovertible and are
universally admitted and which have
received social and practical recognition.
EXAMPLEs:
1) A contract, whereby X promised to live as
the common-law wife of B without the
benefit of marriage in consideration of
P50,000.00, is immoral and, therefore,
void.
2) An agreement to pay usurious interest is
contrary to the usury law (Act No. 2655.)
and morality.
3) An agreement whereby X is to render
service as a servant to Y without
compensation as long as X has not paid
his debt is reprehensible and censurable.
C) CONTRARY TO GOOD CUSTOMS
Customs consist of habits and practices which
through long usage have been followed and
enforced by society or some part of it as binding
rules of conduct. It has the force of law when
recognized and enforced by law.
A custom must be proved as a fact, according to
the rules of evidence. (Art. 12; see Art. 1376.)
“Good customs are expressly mentioned,
although morals are already specified. The
spheres of morals and good customs may
frequently overlap each other but sometimes
they do not.”
It must be admitted, however, that if a moral
precept or custom is not recognized universally,
but is sanctioned by the practice of a certain
community, then it shall be included within the
scope or sphere of good customs.
EXAMPLE: Husband and wife entered into an
agreement to separate mutually and voluntarily.
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D) CONTRARY TO PUBLIC ORDER
Public order refers principally to public safety
although it has been considered to mean also
the public weal.
EXAMPLE: Contract legalizes the commission
of adultery or concubinage.
E) CONTRARY TO PUBLIC POLICY
Public policy is broader than public order, as the
former may refer not only to public safety but
also to considerations which are moved by the
common good.
By public policy is intended that principle of law
which holds that:
 no subject or citizen can lawfully do that
which has a tendency to be injurious to
the public or against the public good
which may be termed the “policy of the
law,’’ or
 “Public policy in relation to the
administration of the law.
“In the absence of express legislation or
constitutional prohibition = a court, in order to
declare a contract void as against public policy,
must find that the contract as to the
consideration or thing to be done:
 Has a tendency to injure the public, is
against the public good
 Contravenes some interests of society
 Inconsistent with sound policy and good
morals
 Tends clearly to undermine the security
of individual rights, whether of personal
liability or of private property.”
EXAMPLES:
1) X stole the car of Y. Later, they entered
into a contract whereby Y would not
prosecute X in consideration of P1,
000.00

It is to the interest of society that crimes be
punished. The agreement between X and Y is,
therefore, contrary to public policy because it
seeks to prevent or stifle the prosecution of X for
theft.
2) A condition in a contract of sale states:
“In case of sale, the buyer shall not sell to
others the land sold but only to the seller,
or to his heirs or successors for the same
price of P5,600.00 when the latter shall
be able to pay it.’’
The condition is contrary to public policy,
because it virtually amounts to a perpetual
restriction on the right of ownership, specifically
the owner’s right to freely dispose of his
property.
3) In a labor case, 52 employees signed a
contingent fee contract whereby they
agreed to pay their lawyer 50% of back
salaries that may be awarded to them.
The validity of a contingent fee contract
depends in large measure on the
reasonableness of the stipulated fees
under the circumstances of each case.
4) The charter party between the petitioner
and private respondent stipulated that
the “owners shall not be responsible for
the loss, split, short landing, breakages
and any kind of damages to the cargo.’’
The stipulation, in effect, exempts the
owner, a private carrier, from liability
even for the negligence of its agents.
Is the stipulation valid? Yes. Article 1745 and
other Civil Code provisions on common carriers
may not be applied unless expressly stipulated
by the parties in their charter party. If the
petitioner were a common carrier, the stipulation
is void as it would be contrary to public policy.
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EFFET OF CONTRACT AS TO
THIRD PARTIES
ART. 1308. The contracts must bind both
contracting parties; its validity or compliance
cannot be left to the will of one of them. (1256a)
The validity or fulfillment of a contract cannot
be left to the will of one of the contracting
parties. This rule is expressly declared by Art.
1308. It must be observed, however, that what
is prohibited by the law from being delegated to
one of the contracting parties are:
1) The power to determine whether or not
the contract shall be valid;
2) The power to determine whether or not
the contract shall be fulfilled.
Art. 1309. The determination of the
performance may be left to a third person,
whose decision shall not be binding until it has
been made known to both contracting parties.
The validity or fulfillment may be left to the will
of a third person. This rule is now expressly
recognized in Art. 1309 which states that the
determination of the performance of a contract
may be left to the will of a third person whose
decision shall not be binding until it has been
made known to each of the contracting parties.
It is, however, an indispensable requisite that
the determination made by the third person
should not be evidently inequitable. If it is
evidently inequitable, it shall not have any
obligatory effect upon the contracting parties.
1) DETERMINATION OF PERFORMANCE
BY A THIRD PERSON (ART 1309)
- Under the preceding article, compliance
with a contract cannot be left to the will of
one of the contracting parties. However,
under the above provision, the
determination of its performance may
be left to a third person. The decision,
however, of the third person shall bind
the parties only after it has been made
known to both of them.

EXAMPLE: A sold his parcel of land to B. It was
agreed that X, a real estate appraiser, would be
the one to determine the reasonable price of the
land. (see Art. 1469.) X, then, fixed the price
after considering all the circumstances and
factors affecting the value of the land.
In this case, X must make known his decision to
A and B who will be bound by the same.
ART. 1312. In contracts creating real rights,
third persons who come into possession of the
object of the contract are bound thereby, subject
to the provisions of the Mortgage Law and the
Land Registration Laws.
2) WHEN POSSESSION OF THE OBJECT
OF THE CONTRACT IS WITH A THIRD
PERSON (Art 1312) or CONTRACTS
CREATING REAL RIGHTS
- This article is an exception to the general
rule that a contract binds only the parties.
- Third persons who come into possession
of the object of a contract over which
there is a real right, such as a real
estate mortgage, are bound thereby
even if they were not parties to the
contract.
- A real right is binding against the whole
world and attaches to the property over
which it is exercised wherever it goes.
- Thus, a contract subjecting certain real
properties to the payment of certain
debts, registered in accordance with the
Property Registration Decree,
constitutes a real right, which is produced
not by the contract but by the publicity
given by the Registry, such publicity
prejudicing the right of third persons.
- If the real right is not registered, third
persons who acted in good faith are
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protected under the provisions of the
Property Registration Decree.
- It is well-known in our jurisdiction that
persons dealing with registered land
have the legal right to rely on the face of
the Torrens Certificate of Title (TCT) and
to dispense with the need to inquire
further, except when the party concerned
has actual knowledge of facts and
circumstances that would impel a
reasonably cautious man to make such
inquiry.
EXAMPLE: Thus, if A mortgages his house
and lot to the PNB in order to secure an
obligation of P2,000,000 and such mortgage
is registered in the Registry of Property, the
effect of such registration is to create a
real right which will be binding against
the whole world. Hence, if the property is
subsequently sold to B, the contract of
mortgage between A and PNB will be
binding upon him.
Similarly, if a third person comes into
possession by whatever title of a certain
property which had been leased by the
previous owner to another person, and such
lease was recorded in the Registry of
Property, such third person shall be
bound thereby.
Art. 1313. Creditors are protected in cases
of contracts intended to defraud them.
3) CREDITORS OF CONTRACTING
PARTIES
Contracts in Fraud of Creditors. — Although
a third person cannot ask for the annulment of a
contract, nevertheless, if he is a creditor of one
of the contracting parties, and it can be
established that the contract was entered into
with the intention of defrauding him, he may ask
for its rescission. This is what is meant by the

Code when it says that creditors are protected
in cases of contracts intended to defraud him.
This rule must, therefore, be read always in
relation to the provisions of Arts. 1380, et seq.,
of the Civil Code, as well as Art. 1177.
DE LEON:
Right of creditor to impugn contracts
intended to defraud them.
The creditor, although he is not a party to the
contract, is given the right to impugn the
contracts of his debtor intended to defraud
him (Art. 1177.), such as contracts undertaken
by a debtor in fraud of his creditor without the
knowledge of the latter. (Art. 1381[3].) He can
sue to rescind the contract to prevent fraud upon
him.
Article 1177. The creditors, after having
pursued the property in possession of the debtor
to satisfy their claims, may exercise all the rights
and bring all the actions of the latter for the same
purpose, save those which are inherent in his
person; they may also impugn the acts which
the debtor may have done to defraud them
(ACCION PAULIANA).
Article 1381. The following contracts are
rescissible:
(3) Those undertaken in fraud of creditors when
the latter cannot in any other manner collect the
claims due them;
Right of creditor to enforce contracts of
debtor with a third person.
In some cases, the law gives a right of action to
a creditor to enforce a contract entered into by
his debtor with a third person. Thus:
(1) Those who put their labor upon or furnish
materials for a piece of work undertaken by
the contractor have an action against the
owner up to the amount owing from the latter
to the contractor at the time the claim is
made. (Art. 1729.)
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(2) The lessor may recover rent due from a sub
lessee since the sub lessee is subsidiarily
liable to the lessor for any rent due from the
lessee. (Art. 1652.)
ART. 1314. Any third person who induces
another to violate his contract shall be liable
for damages to the other contracting party.
4) INTERFERENCE BY THIRD PARTIES
Interferences with Contractual
Relations. — Art. 1314 enunciates the
doctrine that any third person who
induces another to violate his contract
shall be liable for damages to the other
contracting party.
The theory of the inference or
inducement gives rise to liabilities for
damages because it violates the right to
perform a contract and to reap the
profits resulting from such performance,
and also the right to performance by the
other party, are property rights which
entitle each party to protection, and to
seek compensation by an action in tort
for any interference therewith.
Article 1314 recognizes an instance
when a stranger to a contract can be
sued for damages for his unwarranted
interference with the contract. The tort or
wrongful conduct is known as
“interference with contractual relations.
REQUISITES:
1) The existence of a valid contract
2) Knowledge on the part of the third
person of the existence of the
contract; and
3) Interference by the third person
without legal justification or excuse.
As far as the third requisite is
concerned, “malice, in some form, is
generally implied from the act of

interference with contractual
relations, and is declared to be an
essential ingredient in such cases.
EXAMPLE:
1) After agreeing to sell his parcel of land to B,
A sells the land to C instead because of the
inducement of D.
In this case, B can sue D for damages.
However, the liability of D for damages cannot
be more than that of A for the latter’s violation of
Art. 1314, his contract. To hold D liable for
damages in excess of those that can be
recovered against A “would lead to a result at
once grotesque and unjust.’’
2) C,” a very popular movie star, was under
contract with “D’’ Movie Productions to star
exclusively in the latter’s films for two years.
“C’’ was prohibited by the contract to star in
any film produced by another producer.
“E’’ Film Co. induced “C’’ to break her
contract with “D’’ Movie Productions by
giving her twice her salary. “D’’ Movie
Productions sued “E’’ Film Co. for damages.
“E’’ Film Co. contended that it had a right to
compete for the services of “C” and that her
contract with “D” Movie Productions was in
restraint of trade and a restriction on her
freedom of contract.
Whose contention would you sustain? (1980
Bar Problem)
Answer — The contention of “D’’ Movie
Productions should be sustained.
NOTE:
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MUTUALITY
Art. 1308. The contract must bind both
contracting parties; its validity or compliance
cannot be left to the will of one of them.
Article 1309. The determination of the
performance may be left to a third person,
whose decision shall not be binding until it
has been made known to both contracting
parties.
Article 1310. The determination shall not be
obligatory if it is evidently inequitable. In
such case, the courts shall decide what is
equitable under the circumstances.
Article 1473. The fixing of the price can
never be left to the discretion of one of the
contracting parties. However, if the price
fixed by one of the parties is accepted by the
other, the sale is perfected.
Mutuality of Contracts. — One of the most
fundamental characteristics of contracts is
the essential equality of the contracting
parties or what is sometimes called the
mutuality of contracts.
Principle of mutuality of contract- A
contract is an agreement which gives rise to
obligations. It must bind both parties in
order that it can be enforced against
either. Needless to say, a contract can be
renewed, revived, extended, abandoned,
renounced, or terminated only by mutual
consent of the parties. Without this mutuality
and equality between the parties, it cannot
be said that the contract has the force of law
between them.
This is deducible not only from the very
nature of contracts, but also from Art. 1308.
From this principle, the law expressly or
impliedly recognizes the following
consequences:

(1) The validity or fulfillment of a contract
cannot be left to the will of one of the
contracting parties. This rule is
expressly declared by Art. 1308. It must
be observed, however, that what is
prohibited by the law from being
delegated to one of the contracting
parties are: first, the power to determine
whether or not the contract shall be valid;
and second, the power to determine
whether or not the contract shall be
fulfilled.
(2) The validity or fulfillment may be left
to the will of a third person. This rule is
now expressly recognized in Art. 1309 which
states that the determination of the
performance of a contract may be left to the
will of a third person whose decision shall not
be binding until it has been made known to
each of the contracting parties.
It is, however, an indispensable requisite
that the determination made by the third
person should not be evidently inequitable. If
it is evidently inequitable, it shall not have
any obligatory effect upon the contracting
parties.
(3) The validity or fulfillment can be left to
chance. This can be deduced a sensu
contrario from the text of Art. 1308.
Renunciation or violation of contract. — It is
an elementary rule that no party can renounce
or violate the law of the contract unilaterally or
without the consent of the other. Hence, “its
validity or compliance cannot be left to the will of
one of them.” (Art. 1308; see Art. 1182.)
Just as nobody can be forced to enter into a
contract, no one may be permitted to change his
mind or disavow and go back upon his own acts,
or to proceed contrary thereto, to the prejudice
of the other party.
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Proof of alleged defect in contract. — If after
a perfect and binding contract has been
executed between the parties it occurs to one of
them to allege defect as a reason for annulling
it, the alleged defect must be conclusively
proved since the validity and fulfillment of
contracts cannot be left to the will of one of the
contracting parties.
It is the duty of every contracting party to learn
and know the contents of a document before he
signs and delivers it.
Release of obligor from compliance. — The
mere fact that a party to a contract has made a
bad bargain, may not be a ground for setting
aside the agreement. (see Art. 1355.) Where,
however, the performance of the contract has
become so difficult as to be manifestly beyond
the contemplation of the parties, the obligor may
be released therefrom, in whole or in part. (Art.
1267.) The debtor in obligations to do shall also
be released when the prestation becomes
legally or physically impossible without the fault
of the obligor. (Art. 1266.)
Effect where determination inequitable (Art
1310).
This article is a qualification to Article 1309.
A contracting party is not bound by the
determination if it is evidently inequitable or
unjust as when the third person acted in bad
faith or by mistake. In such case, the courts shall
decide what is equitable under the
circumstances.
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